Capital Budgeting Decision
Here is Project 2:
Hampton Company: The production department has been
investigating possible ways to trim total production costs. One
possibility currently being examined is to make the cans instead of
purchasing them. The equipment needed would cost $1,000,000, with a
disposal value of $200,000, and would be able to produce 27,500,000
cans over the life of the machinery. The production department
estimates that approximately 5,500,000 cans would be needed for
each of the next 5 years.
The company would hire six new employees. These six
individuals would be full-time employees working 2,000 hours per
year and earning $15.00 per hour. They would also receive the same
benefits as other production employees, 15% of wages in addition to
$2,000 of health benefits.
It is estimated that the raw materials will cost 30¢ per can
and that other variable costs would be 10¢ per can. Because there
is currently unused space in the factory, no additional fixed costs
would be incurred if this proposal is accepted.
It is expected that cans would cost 50¢ each if purchased
from the current supplier. The company’s minimum rate of return
(hurdle rate) has been determined to be 11% for all new projects,
and the current tax rate of 35% is anticipated to remain unchanged.
The pricing for the company’s products as well as number of units
sold will not be affected by this decision. The unit-of-production
depreciation method would be used if the new equipment is
purchased.
Required:
1. Based on the above information and using Excel, calculate
the following items for this proposed equipment purchase.
Annual cash flows over the expected life of the equipment
Payback period
Simple rate of return
Net present value
Internal rate of return
The check figure for the total annual after-tax cash flows is
$271,150.
2. Would you recommend the acceptance of this proposal? Why
or why not? Prepare a short, double-spaced paper in MS Word
elaborating on and supporting your answer.
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